Forex: Euro Hit By Debt Fears, U.S. Dollar Reversal To Accelerate

The Euro continued to pare the advance from the previous week, with the EUR/USD slipping to a low of 1.3889 on Tuesday, and the single-currency may face additional headwinds ahead of the EU Summit later this week as the sovereign debt crisis deepens.

Talking Points

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The Euro continued to pare the advance from the previous week, with the EUR/USD slipping to a low of 1.3889 on Tuesday, and the single-currency may face additional headwinds ahead of the EU Summit later this week as the sovereign debt crisis deepens. Greece's 10-Year yield climbed to 12.77% during the overnight, which was the highest since the euro was introduced in 1999, and the governments operating under the fixed-exchange rate system may continue to face higher borrowing costs as the risk for contagion intensifies. As European policy makers maintain a relaxed approach in address the debt crisis, market participants speculate Portugal to share Ireland's ill fate, and the uncertainties surrounding the real economy certainly hampers the outlook for the euro as the region faces an uneven recovery.

Indeed, currency traders showed little reaction to the hawkish comments from the European Central Bank even as board member Axel Weber encouraged the Governing Council to establish an exit strategy over the coming months, and the Governing Council certainly faces an uphill battle as it aims to balance the risks for the region. As the European debt crisis comes into focus, the small correction in the EUR/USD may gather pace going into the middle of the week, and the exchange rate may work its way back towards the 20-Day SMA (1.3728) as the relative strength index falls back from overbought territory. However, as the ECB shows an increased willingness to normalize monetary policy in the first-half of 2011, speculation for higher borrowing costs may help to prop up the single-currency, and the exchange rate may trade within a broad range over the near-term as investors weigh the outlook for future policy.

The British Pound slipped to a fresh monthly low of 1.6141, but the sterling may regain its footing going into the middle of the week as the Bank of England is widely expected to maintain its current policy in March. According to Credit Suisse overnight index swaps, investors see the BoE raising the benchmark interest rate by 75bp over the next 12-months, and hawkish comments from the central bank is likely to spark a bullish reaction in the British Pound as rate expectations gather pace. However, the central bank may refrain from releasing a policy statement as it keeps monetary policy unchanged, and the BoE Minutes due out on March 23 is likely to set the tone for future price action given the growing shift within the MPC. As the GBP/USD tests the upward trendline from earlier this year for near-term support, there could be a small rebound in the exchange rate during the North American trade, but the sterling may struggle to hold its ground as investors scale back their appetite for risk.

The U.S. dollar bounced back against most of its major counterparts following a flight to safety, and the greenback may continue to appreciate throughout the North American trade as the political turmoil in the Middle East paired with the European debt crisis continues to bear down on market sentiment. As the economic docket remains fairly light for Tuesday, risk trends are likely to dictate price action for the major currencies, and the rebound in the reserve currency may gather pace going forward as the uncertainties surrounding the global economy intensifies.

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